Should You Buy These Hot Investments?

Everyone knows that investors like to follow the herd. After all, who can resist the siren song of hot performance from a certain stock or sector of the market? Unfortunately, this herd mentality can often end up hurting investors more than it helps.

According to data from Morningstar and U.S. News, here are the 10 funds that saw the greatest net inflows through the end of October of this year:

So are investors plowing into these funds right now making smart investment choices or setting themselves up for a fall?

Bonds away!
Well, it can't escape anyone's notice that of the 10 funds listed, six are bond funds (and one is a balanced allocation fund that invests heavily in bonds). Apparently, despite warnings from an increasing number of market strategists that fixed income is at the end of its bull market run, investors aren't taking heed. Fear is outpacing greed and despite the fact that the stock market has more than doubled since its lows in early 2009, people are still running for the safety of bonds. And while bond returns have continued to be favorable, that train has just about reached the end of the line.

It's perfectly possible that the stock market could hit some more serious bumps, especially if the tax hikes and spending cuts of the fiscal cliff aren't largely avoided and the economy falls back into recession. But given that interest rates are at historical lows and can't fall much further, bonds are looking pretty expensive nowadays. And anyone expecting them to continue putting up the kind of returns they have in recent years is bound to be disappointed. While you shouldn't shun bonds totally, especially if you are in or close to retirement, at this point you should seriously consider adding any new money to equities, especially those of the higher-quality variety.

Best of the bond world
As for the specific funds that investors have chosen to grace with their money, it looks like investors are actually making some decent choices. Of course, just about all of these funds have done very well return-wise, so there is undoubtedly some performance-chasing going on. But there are some first-rate actively managed bond funds in the mix, including DoubleLine Total Return Bond, the flagship fund of bond maven Jeffrey Gundlach's relatively new asset management shop, DoubleLine Capital. After leaving TCW three years ago, Gundlach and his team have managed to put together another impressive track record, with Total Return Bond earning 12% on an annualized basis since its inception, compared to a 6.3% gain for the benchmark Barclays Aggregate Bond Index.

Likewise, Bill Gross' PIMCO Total Return fund now ranks as the single largest mutual fund in existence, with more than $285 billion under its belt. The fund also ranks in the top 6% of all intermediate-term bond funds over the past 15 years, so it's not hard to see why investors are making a beeline for Bill Gross and his bonds. Most of the other bond funds on the top-10 list are also pretty reasonable choices for bond investors, so while investors are certainly moving too heavily into fixed income, it looks like they are at least picking decent funds to do it with, for the most part.

Stocks for skeptics
The fact that two of the three stock funds in the top-10 inflow list are index funds seems to reinforce the notion that a fair number of investors are souring on active management, at least on the equity side. After suffering through the market's sharp dive in 2007-2009, more and more investors are questioning why they should pay higher fees for active management only to ride the downturn along with everyone else. If you are one of the many who has soured on active managers, don't let that drive you away from stocks in general. While there are many solid actively managed funds that can and do beat the market consistently, if you're doubtful, at least invest in a low-cost index fund rather than sit it out.

The Vanguard Total International Stock Index and Total Stock Market Index funds, members of the top-10 list above, are two great choices for cheap, broad-market exposure. But if you want an even cheaper play, consider the ETF versions of these funds. Vanguard Total International Stock ETF (VXUS -0.13%) will only set you back 0.18% while Vanguard Total Stock Market ETF (VTI -0.46%) comes with a super-low 0.06% price point. Other great, inexpensive broad market Vanguard ETFs for hesitant stock market investors include the Vanguard Small-Cap ETF (VB -0.52%) to boost small-cap coverage and Vanguard Dividend Appreciation ETF (VIG -0.20%) to crank up the dividend power in your portfolio. And if you need some bond exposure as well, the Vanguard Total Bond Market ETF (BND -0.26%) is the ETF counterpart to the Vanguard Bond Index Fund in the list above, charging a mere 0.10% compared to 0.22% for the index fund.

Ultimately, investors who continue to rush into bonds are going to regret it. Equities are likely to remain a volatile investment in the short run, but there is little doubt that they are more attractively priced than bonds at this point. So get some skin in the game, perhaps by picking up a cheap exchange-traded fund that gives you well-diversified coverage in one shot. And remember, just because the herd is going one way doesn't mean you have to follow.